Question

Q-mart failed to include inventory that was kept in a separate warehouse in its 12/31 end-of-the-period inventory count. Consequently, the ending inventory on 12/31 was understated on the balance sheet. Explain how this error will effect the income statement. (Check all that apply.)

Answer 1

Answer:

If the ending inventory was understated, that means that the cost of goods sold will be overstated. If the cost of goods sold was overstated, then net profits were understated.

Explanation:

Imagine a company that sells shoes:

It bought 100 shoes at $100 each during the whole year and their ending inventory was 10 units. This means that cost of goods sold was (100 - 10) x $100 = $9,000. But someone discovered 5 pairs in some shelf that were not included in the ending inventory, then the real ending inventory was 15 units = $1,500 and not $1,000. That also means that the cost of goods sold was $8,500, not $9,000. Lower costs = higher profits.